Mortgage Lending: Is This a Slump or Stability?

A recent story from Bloomberg News reported that mortgage lending had slowed to a 17-year low. Is this a sign of weakness in the housing market? Not necessarily.

Certainly, along with the drop in mortgage activity, home price gains have stalled in recent months. However, after the manic, boom-or-bust behavior of the housing market over the past 15 years, this might not be a slump, but rather a return to stability. That would make for a calmer environment in which home buyers could make measured decisions.

Slower Mortgage Activity Is Not All Due to Slower Demand

The headline figure is that mortgage lending activity in the first quarter of 2014 fell to its lowest level since 1997. However, this is not entirely indicative of a fall-off in demand for housing.

For one thing, a major part of the slowdown in lending activity comes from a decline in refinancing rather than purchase activity. This is partly because of a rise in refinance rates over the past year and partly because of refinancing burnout -- refinance rates were so low for so long that most people who were in a position to refinance a mortgage have already done so. In any event, a decline in refinancing activity does not take new demand out of the housing market.

Also, Bloomberg reports that some of the slack in lending is being picked up by all-cash purchases, which have more than doubled as a percentage of US residential purchases over the past year. This is a form of home-buying demand that is not directly affected by the rise in mortgage rates.

Prices Level Off

It does appear that higher mortgage rates have cooled the hot streak that home prices had enjoyed for most of the past two years. According to the S&P/Case-Shiller Home Price Indices, the composite of prices in 10 major US cities has been essentially unchanged over the most recent four months of data and is up just 2 percent over the past six months.

Still, these price changes reflect a leveling off rather than a downturn, and that 2 percent gain over the past six months is more typical of the steady types of increases that preceded the feverish rise of the housing boom. Those steady increases are also in contrast to the steep drops that followed the boom. In short, recent home price movements suggest neither boom nor bust, but stability.

Mortgage Rates Flatten Out, Too

The overhanging context for any discussion of the housing market is the fact that mortgage rates have risen over the past year. According to data from the Federal Reserve, 30-year fixed mortgage rates averaged 4.34 percent in March of 2014 after averaging 3.57 percent a year earlier. The concern is that this rise in mortgage rates could be choking off demand for housing.

It is true that low mortgage rates encourage home buying, but the increase in mortgage rates seems to have calmed down in recent months. After rising sharply in the second quarter of last year, 30-year fixed mortgage rates have been essentially flat for eight months now. This gives home buyers a chance to adjust to the market rather than to find continually rising rates that repeatedly jack up the cost of borrowing.

Mortgage Rates Approach More Normal Levels

Finally, there is some concern that the housing market is overly dependent on unusually low mortgage rates and that prices could not survive a return of rates to more normal levels. On the surface, the contrast between current and historical rates is jarring. At 4.34 percent, recent 30-year fixed mortgage rates were more that 4 percentage points lower than the 40-year average of 8.59 percent.

However, what has to be taken into account in assessing how low mortgage rates currently are is the inflation environment. According to data from the Bureau of Labor Statistics, inflation averaged 4.08 percent over the past 40 years, during which time the average 30-year fixed mortgage rate was 4.51 percent higher than inflation. Over the past year though, inflation has been just 1.5 percent. Adjusting for lower inflation then, current 30-year fixed mortgage rates are only about 1.7 percent below normal, not more than 4 percent below. This suggests that relatively low mortgage rates can be sustained -- as long as inflation remains under control.

Naturally, people associated with the housing industry are disappointed to see a rally in home prices and lending activity lose momentum. Viewed from a longer-term perspective though, recent trends in mortgage rates and home prices seem like moves toward greater stability.

It could be that this is simply a return to normalcy -- it's just that after the wild housing market of the past 15 years, nobody recognizes what normal looks like.